What Is a Gold Option?
A gold option is an options contract that utilizes either physical gold or gold futures as its underlying asset.
A gold call option would give the holder the right,but not the obligation, to buy bullion at a future date at a set price, while a put option would grant the holder the right to sell it at a predetermined price level. The option agreement terms will list details such as the delivery date, quantity, and strike price, which are all predetermined.
Key Takeaways
- Gold options are options contracts that utilize either physical gold or gold futures as their underlying instrument.
- Call options on gold give the contract holder the right to buy the metal at a preset price before it expires.
- Put options work in the opposite way, granting the right to sell at a predetermined price level.
- Gold options trading in the U.S. are listed on the CME COMEX and use gold futures, which represent 100 troy ounces of gold, as the underlying asset.
Understanding Gold Options
A gold optionis a derivativethat has physical gold, or futures on physical gold, as the underlying asset.
The gold options contract is an agreement between two parties to facilitate a potential transaction on a quantity of gold.The contract lists a preset price, knownas thestrike price, and an expiration date.
There are two primary types of options contracts: put options and call options. However, there are four types of participants, as both the call and put can beeither bought or sold.
Types of Gold Options
- Call gold options: Givethe holder the right, not the obligation, to buy a specific amount of gold atthestrike price until theexpiration date.A call option becomes more valuable as the price of gold increases because they locked in a buy at a lower price. When you buy the call, you have the right, but not the obligation, to purchase the gold. If, on the other hand, you sell the call, you do not have a choice and must sell the gold at the predetermined price when the person holding the opposite side of the contract demandsdelivery up to the expiration date.
- Put gold options: Givethe owner the right, but not the obligation, to sella specific amount of gold atthestrike price until theexpiration date.A put option becomes more valuable as the price of gold decreases because they locked in a sell at a higher price. If you buy the put, you have the right, but not the obligation, to sell the gold. Meanwhile, when you sell a put, youdo not have a choice andmust purchase the gold at the predetermined price from the person holding the opposite side of the contract.
If the holders of call or put options do not exercise their rights, the contract will expire asworthless.
Gold Options vs. Gold Future Contracts
A gold option is similar in some ways to a goldfutures contract in that the price, the expiration date, and the dollar amount are preset for both. However, with afutures contract, there is an obligation to uphold the agreement and either buy or sell the agreed-upon quantity of gold at the agreed-upon price.
Conversely, an investor who holds a gold option has the right, but not the obligation, to claim the relevant position, which will depend on if they hold the call option or the put option.
Gold Options Contract Specifications
Gold options contracts trade on various derivatives exchanges around the world. In the U.S., investors can find gold options listed on the COMEX exchange.
COMEX is the primary futures and options market for trading metals such as gold, silver, copper, and aluminum. Formerly known as the Commodity Exchange Inc., COMEX merged with the New York Mercantile Exchange (NYMEX) in 1994 and became the division responsible for metals trading. Today, COMEX—and the NYMEX more broadly—operates as a division of theChicago Mercantile Exchange (CME).
COMEX gold options actually use gold futures, rather than physical gold directly, and so are cash-settled. These gold futures have a contract size of 100 troy ounces each and require physical delivery if not closed out.
It is possible to experience significant losses with gold options.
The Condition for Exercising Gold Options
As with other types of options, an investor would only want to exercise their gold option rights if the market conditions make it beneficial.
If at the time the buyer can use, or exercise, their call option, gold is trading at a price significantly higher than the strike price, the investor would benefit by exercising their option. The investor could then turn around and quickly sell that gold on the open market for a quick profit.
Should, on the other hand, gold be trading at or near the strike price, the investor may break even or perhaps even take a loss once their initial cost to purchase the option is factored in.
How Can I Buy Options on Gold?
Gold options are available the U.S. through theChicago Mercantile Exchange(CME). These options contracts use gold futures as their underlying asset. To trade gold options, you will need a margin brokerage account with access to options markets. You could contact your current broker to see if they offer options trading or shop around for an options trading account.
What Are the Types of Gold Options?
Call options on gold give the contract holder the right, but not the obligation, to buy the metal at a preset price before the contract expires. A call option increases in value when the price of gold increases, as it locks in a lower buying price. Meanwhile, put options give the contract holder the right to sell gold at a predetermined level before the expiration date. As gold prices decline, a put option becomes more valuable, as it locks in a higher selling price.
What Are the Pros and Cons of Gold Options?
Gold options allow traders to take out a position on gold using less up-front capital than they would by trading the physical metal or gold futures contracts. However, if gold prices move in an unfavorable direction, options can result in significant losses.
The Bottom Line
Gold options give the holder the right, but not the obligation, to buy or sell gold at a specific price, up until the contract expires. With a call option, the contract holder reserves the right to buy gold at a specific price, while a put option holder reserves the right to sell at a predetermined level. To trade gold options, it is necessary to have a margin brokerage account offering access to options markets.
